INFLATION FEARS: REAL OR HYSTERIA?

Debate continues to rage between the inflationists who say
the money supply is increasing, dangerously devaluing the currency, and the deflationists
who say we need more money in the economy to stimulate productivity. The
debate is not just an academic one, since the Fed’s monetary policy turns on it
and so does Congressional budget policy.

Inflation fears have been fueled ever since 2009, when the Fed began
its policy of “quantitative easing” (effectively “money printing”). The inflationists
point to commodity prices that have shot up. The deflationists, in turn, point to
the housing market, which has collapsed and taken prices down with it. Prices of
consumer products other than food and fuel are also down. Wages have remained stagnant,
so higher food and gas prices mean people have less money to spend on consumer goods.
The bubble in commodities, say the deflationists, has been triggered by the fear
of inflation. Commodities are considered a safe haven, attracting a flood of “hot
money” -- investment money racing from one hot investment to another.

To resolve this debate, we need the actual money supply figures.
Unfortunately, the Fed quit reporting M3, the largest measure of the money supply,
in 2006.

Fortunately, figures are still available for the individual
components of M3. Here is a graph
that is worth a thousand words. It comes from ShadowStats.com (Shadow Government
Statistics or SGS) and is reconstructed from the available data on those components.
The red line is growth in the M3 money supply as reported by the Fed until 2006. The blue line is the growth in M3 after 2006.

The chart shows that the overall U.S. money supply is shrinking,
despite the Fed’s determination to inflate it with quantitative easing. Like Japan,
which has been doing quantitative easing (QE) for a decade, the U.S. is still fighting
deflation.

Here is another telling chart – the M1 Money Multiplier from
the Federal Reserve Bank of St. Louis:

Barry Ritholtz
comments, “All that heavy breathing about the flood of liquidity that was going
to pour into the system. Hyper-inflation! Except not so much, apparently.” He quotes
David Rosenberg: “Fully 100% of both QEs by the Fed merely was new money printing
that ended up sitting idly on commercial bank balance sheets. Money velocity and
money multiplier are stagnant at best.” If QE1 and QE2 are sitting in bank reserve
accounts, they’re not driving up the price of gold, silver, oil and food; and they’re
not being multiplied into loans, which are still contracting.

The part of M3 that collapsed in 2008 was the “shadow banking
system,” including money market funds and repos. This is the non-bank system in
which large institutional investors that have substantially more to deposit than
$250,000 (the FDIC insurance limit) park their money overnight. Economist Gary Gorton
explains:

[T]he financial crisis . . . [was] due to a banking panic
in which institutional investors and firms refused to renew sale and repurchase
agreements (repo) – short-term,
collateralized, agreements that the Fed rightly used to count as money. Collateral
for repo was, to a large extent, securitized bonds. Firms were forced to sell assets
as a result of the banking panic, reducing bond prices and creating losses. There
is nothing mysterious or irrational about the panic. There were genuine fears about
the locations of subprime risk concentrations among counterparties. This banking
system (the “shadow” or “parallel” banking system)-- repo based on securitization -- is a genuine
banking system, as large as the traditional, regulated banking system. It is
of critical importance to the economy because it is the funding basis for the traditional
banking system. Without it, traditional banks will not lend, and credit, which
is essential for job creation, will not be created. [Emphasis added.]

Before the banking crisis, the shadow banking system composed
about half the money supply; and it still hasn’t been restored. Without the shadow
banking system to fund bank loans, banks will not lend; and without credit, there
is insufficient money to fund businesses, buy products, or pay salaries or taxes.
Neither raising taxes nor slashing services will fix the problem. It needs to be
addressed at its source, which means getting more credit (or debt) flowing in the
local economy.

When private debt falls off, public debt must increase to fill
the void. Public debt is not the same as household debt, which debtors must pay
off or face bankruptcy. The U.S. federal debt has not been paid off since 1835.
Indeed, it has grown continuously since then, and the economy has grown and flourished
along with it.

As explained in an earlier article, the public debt is the people’s money.
The government pays for goods and services by writing a check on the national bank
account. Whether this payment is called a “bond” or a “dollar,” it is simply a debit
against the credit of the nation. As Thomas Edison said in the 1920s:

If our nation can issue a dollar bond, it can issue a dollar
bill. The element that makes the bond good, makes the bill good, also. The difference
between the bond and the bill is the bond lets money brokers collect twice the amount
of the bond and an additional 20%, whereas the currency pays nobody but those who
contribute directly in some useful way. . . . It is absurd to say our country can
issue $30 million in bonds and not $30 million in currency. Both are promises to
pay, but one promise fattens the usurers and the other helps the people.

That is true, but Congress no longer seems to have the option
of issuing dollars, a privilege it has delegated to the Federal Reserve. Congress
can, however, issue debt, which as Edison says amounts to the same thing. A bond
can be cashed in quickly at face value. A bond is money, just as a dollar is.

An accumulating public debt owed to the IMF or to foreign banks
is to be avoided, but compounding interest charges can be eliminated by financing
state and federal deficits through state- and federally-owned banks. Since the government
would own the bank, the debt would effectively be interest-free. More important,
it would be free of the demands of private creditors, including austerity measures
and privatization of public assets.

Far from inflation being the problem, the money supply has
shrunk and we are in a deflationary bind. The money supply needs to be pumped back
up to generate jobs and productivity; and in the system we have today, that is done
by issuing bonds, or debt.